Regulatory action: shock and awe | Expert opinions

We often see regulatory action against various financial entities after the regulator has “inspected their books”. Recent regulatory measures include restrictions on accepting deposits, opening new accounts through online banking channels, issuing co-branded cards, launching new mobile products and managing public debt offerings. These actions reflect regulators’ commitment to maintaining financial stability, fair markets and ensuring compliance with regulations. However, investors are shocked and impressed by such actions because they directly impact them.

Another sector that periodically comes under inspection – and regulatory action – is pharmaceutical companies that export to the United States. Here, inspections are conducted by the United States Food and Drug Administration (FDA) to assess regulated facilities’ compliance with applicable laws and regulations, such as the Food, Drug, and Cosmetic Act, and various other laws related, in order to guarantee the safety and quality of medicines.

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Unlike financial sector reviews and audits, which occur “year-round,” U.S. FDA inspections are conducted every few years with an element of surprise in their timing. FDA investigators arrive on site and present a “notice of inspection,” or Form 482. They then examine the production process, review relevant records, and take samples. At the end of the inspection, observations, called Form 483s, are submitted and serve as a guide for corrective action. This gives the facility the opportunity to take voluntary corrective action and prevent recurrence. In extreme cases, the FDA could recommend a recall of a drug or prevent its export to the United States.

Like financial inspections, Form 483 remains confidential between the regulator and the entity being examined. But I know of two variations. As with the financial sector regulator, FDA inspections are initially confidential. But the FDA reviews the results, the company’s response and other data, and generally categorizes its findings within 90 days into three categories: (i) no action indicated, when there are no significant problems ; (ii) voluntary action indicated, when minor problems requiring correction are identified; and (iii) indicated official action, when serious violations are identified and require enforcement action. The classification is made public.

Second, under the Freedom of Information Act, individuals can request the FDA 483 for a fee. The FDA redacts commercially sensitive information before publishing the document. Unfortunately, there is no time commitment for this, and people sometimes wait up to two years to access this information. This redacted file is then uploaded to the FDA website and is freely available to all stakeholders, including its investors. I have simplified things, but this is the general protocol.

Regulators work to ensure patient safety, fair treatment of borrowers and compliance with the rules. Their actions, while considered somewhat extreme, help them preserve the integrity of the industry they regulate. But it is undeniable that harsh regulatory decisions impact various stakeholders and can have unintended consequences. To give just one example, warning a bank that its systems are vulnerable could lead to an increase in cyberattacks. This is not to say that regulators should overlook the loopholes, but a way must be found to involve investors and other relevant stakeholders in this exchange.

Currently, once an entity hears from the regulator, it discloses the summary to the exchange. If the action is punitive, it leaves investors bruised, who then argue that such action is impulsive, even though the discussion is ongoing.

Should the FDA then first grant a cure period when serious violations are observed? It is difficult to argue given that lives and limbs are at stake, which is why I will focus on the financial sector, where change can be relatively easy. Since inspections are often ongoing, making a public disclosure only after receiving the “final” letter is what causes serious market disruption, particularly if the action is also serious. Disclosures and updates regarding the communication that took place should be encouraged. While it could be argued that any time such information is disclosed for the first time it may result in market volatility, timely and meaningful disclosure in one form or another would better prepare the market.

Financial regulators should also consider categorizing their regulatory communications based on the nature and severity of the findings. They may publish the summary of findings and ultimately the entire inspection report or encourage regulated entities to do so. An annual or semi-annual summary of their inspection findings, without naming specific entities, will also go a long way in articulating regulatory expectations. They should also highlight the best practices they have observed. This will provide stakeholders with the information they seek and all regulated entities with clear indicators of improvement.

The author works for Institutional Investor Advisory Services India Ltd. Opinions are personal. X: AmitTandon_In